Did You Know? Why Low Unemployment Rates May Not Be Such a Good Thing.

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Low unemployment rates are often seen as something to smile about in a bustling economy with plenty of job opportunities. However, the COVID-19 pandemic turned the trend on its head. It caused unemployment to spread like wildfire because of lockdown measures.

The unemployment rate began in February 2020 at a low of 3.5%. At that point, 16.8 million Americans were unemployed. That number surged to 20.5 million by the end of April and much higher afterward. The pandemic simply affected many jobs, forcing businesses to cut back and a sharp spike in unemployment claims.

As the economy slowly rose from the ashes of the pandemic, worker productivity shot up, according to the U.N. agency International Labour Organization (ILO). In a blink, though, it quickly fell back to the depths of the previous 10 years. The ILO research states that real wages and disposable income are frequently prone to sudden shocks due to poor productivity development.

The report says it sees minimal employment gains in upper-middle-income countries coming up over the next two years. That view clashes with solid job growth in low-income and lower-middle-income nations. High-income countries should see a decline in employment growth in 2024 and minor improvements in 2025.

Low unemployment rates, while a good thing for workers and employers, is also a double-edged sword. Some argue that inflation could continue to remain high if spending patterns don’t change. On the other hand, some question why a 3.5% unemployment rate is considered too low, given that most people are employed and the economy remains relatively strong.

Let’s dive more into this debate.

Impacts of Low Unemployment

In September 2019, the U.S. experienced a 50-year record for employment gains. Millions of new jobs hit the economy, a stark contrast to just a decade prior when unemployment rates surged well into the double-digits following the Great Recession. That said, while this is a broadly positive trend, some experts have warned against possible adverse side effects of persistently low unemployment. Here are three to consider.

Difficult recruitment and retention

When unemployment is low, there is more competition for talent. That’s simple to understand. Candidates start to become picky in terms of the companies they choose to work for, which raises turnover. When recruiting becomes hard, recruiters turn to incentives like paying for interviews. To stay competitive, CEOs place a high priority on attracting and keeping people by putting business culture and employee benefits upfront.

Unemployment rates can go two ways, either increase skilled talent availability or hinder recruitment, leading to inefficiencies and increased salary demands, which may shake up profitability. Additionally, these higher costs to employers ultimately feed through to consumers, which can hurt the economy in the long run (via a wage-price spiral).

Decline in productivity

Unemployment can open up doors to output gaps, where new jobs may not make enough productivity to cover costs, making economic waves. Competitive wages are essential to avoid hiring less qualified candidates, making the skill gap more obvious. Overwhelmed employees and stressed top performers are expected, requiring longer work hours.

The output gap changes along with the economy, revealing whether the resources are being over or underutilized. A positive output gap appears when unemployment falls, suggesting possible carelessness. While economists butt heads on the cutoff point, inefficiency can occur when unemployment is less than 5%, such as 3.5%

Indicating recession

Not a fun fact: This is the lowest unemployment rate since 1969. It evokes memories of a similar timeframe that paved the way to a moderate recession. Experts now clash on how to interpret the current status of the economy. Is it the beginning of a positive phase, a little slowdown or a severe downturn?

Business owners walk on eggshells because of uncertainty, the Great Recession and wage stagnation. Employers feel like they’re swimming against the tide with hiring and retention, as evidenced by a decline in worker earnings in September 2019.

What Now?

Experts project a minor increase in layoffs and unemployment in 2024. Lead labor economist Andrew Flowers, of job advertising company Appcast, forecasted that while it will rise from the current 3.7% to 4.2% by year’s end, the rate will not even cross the line beyond 4.5%.

LaborIQ chief economist Mallory Vachon was on the same page that, although layoffs would rise, the unemployment rate was still historically low. He stressed that companies were hesitant to hire new employees, preferring to concentrate on keeping their current workforce.

Flowers blamed the “tech recession,” or post-pandemic hiring correction in the tech sector that has since stabilized, for most of the 2023 layoffs. Although losses in employment happened in other white-collar industries as well, he said things have recently taken a turn for the better, given the stable or increase in job postings.

I’m not sure where the unemployment rate will head from here, and it appears the experts remain mixed on this topic as well. That said, it’s a factor that’s not so black and white, and one investors would do well to keep an eye on throughout the year.

On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Chris MacDonald’s love for investing led him to pursue an MBA in Finance and take on a number of management roles in corporate finance and venture capital over the past 15 years. His experience as a financial analyst in the past, coupled with his fervor for finding undervalued growth opportunities, contribute to his conservative, long-term investing perspective.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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